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Unit-IV

The document discusses working capital management, highlighting its importance for a company's liquidity and short-term financial health. It explains concepts such as gross and net working capital, along with different financing policies and approaches for managing current assets. Additionally, it covers factors influencing working capital requirements, the operating and cash conversion cycles, and methods for estimating and determining optimal levels of current assets.

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16 views16 pages

Unit-IV

The document discusses working capital management, highlighting its importance for a company's liquidity and short-term financial health. It explains concepts such as gross and net working capital, along with different financing policies and approaches for managing current assets. Additionally, it covers factors influencing working capital requirements, the operating and cash conversion cycles, and methods for estimating and determining optimal levels of current assets.

Uploaded by

madhavaswamy72
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Corporate Finance-II

Working Capital Management


Unit-IV

Presented By:

Dr. Naveen Chinni


Assistant Professor, GSB-
Hyderabad
Working Capital
It reflect the liquidity resources avaiable to a business to run its day-to-day operations, and it’s an
indicator of a company’s short-term financial health.

Concepts of working capital:

There are two concepts of working capital – gross and net working capital

Gross working capital: refers to the firm’s investment in current assets. It focus on two aspects:
(a) How to optimize investment in current assets
(b) How should current assets be financed.

Net working capital: refers to the difference between current assets and current liabilities.
It focus on two aspects:
(a) Liquidity position of the company
(b) Extent to which the working capital needs may be financed by
permanent sources of funds.
Permanent working capital (Fixed working capital): It is the minimum working capital
required . It is permanent in the same way as fixed assets are.

Variable (fluctuating working capital): It is the extra working capital needed to support the
changing production and sales activities of the firm.

Working Capital Management: refers to the process of managing a company’s short-term


assets and liabilities to ensure efficient operation and maintain sufficient cash flow to meet short-
term obligations.
Factors influencing working capital requirements

1. Nature of the business


2. Seasonality of operations
3. Production policy
4. Market conditions
5. Conditions of supply
6. Credit policy
7. Availability of credit from suppliers
8. Operating efficiency
9. Price level changes
Policies for Financing current assets

A firm can adopt different financing . What should be the mix of short and long term sources in
financing current assets? There are three approaches to answer this question.

1. Matching approach or hedging approach.


2. Conservative approach
3. Aggressive approach
Matching approach: It implies that, there is a match between expected life of assets with the
expected life of the source of funds raised to finance assets.

 Long-term financing will be used to finance fixed assets and permanent current assets
(Permanent working capital)
 short-term financing to finance temporary or variable current assets (Temporary working
capital).
Conservative Approach: In this policy, the firm finances its permanent assets and also a part of
temporary current assets with long-term financing.

In the periods when the firm has no need for temporary current assets, the idle long-term funds
can be invested in the tradable securities to conserve the liquidity.
Aggressive Approach: It uses more short-term financing than warranted by the matching plan.
Under this approach, the firm finances a part of permanent current assets with short-term
financing.
Operating cycle: The time that elapses to convert raw materials into cash is known as operating cycle

Operating cycle = Inventory conversion period + Debtors conversion period


OC = ICP + DCP

ICP = 365 Days / Inventory Turnover Ratio

DCP = 365 Days / Debtors Turnover Ratio

Problem: ABC Company provided the following information and requested you to compute the operating cycle:

Sales: Rs. 3,000 lakh


Inventory: Opening: 610 Lakh closing: 475 Lakhs
Debtors: Opening- 915 Lakhs Closing 975 Lakh
Cost of goods sold- 2675
Cash cycle: The time period between the date of a firm pays its suppliers and the date it receives cash from
customers.

Cash conversion cycle = Operating cycle – Accounts payable period

Accounts payable period = 365 days / Creditors Turnover ratio

From the following information of Vamsadhara co.Ltd determine Cash Conversion cycle

Sales = Rs. 1587.95 Lakh


Cost of goods sold = Rs. 1406.27 Lakhs
Inventory: Opening- 195.82 Lakhs Closing-202.29 Lakhs
Accounts receivable: Opening – 423.03 Lakh Closing – 449.46 Lakh
Accounts payables: Opening – 140.40 Lakh closing – 168.33 Lakh
Estimating working capital needs:

There are three approaches to estimate the working capital needs.

1. Current assets holding period


2. Ratio of sales
3. Ratio of fixed investment.
From the following information of VSGR Company ltd., estimate the working capital needed to
finance a level of activity of 1,10,000 units of production after adding a 10% safety contingency.
Particulars Cost Per Unit (Rs.)
Raw Materials 78
Direct Labour 29
Overheads (Excluding 58
depreciation)
Total Cost 165
Profit 24
Selling Price 189

Additional Information:
Average raw materials in stock: one month
Average materials-in-process (50% completion stage): Half a month
Average finished goods in stock: one month
Credit allowed by supplier: one month
Credit allowed to customer: two months
Time lag in payment of wages: one and half weeks
Overheads expenses: one month

One fourth of the sales is on cash basis. Cash balances is expected to be Rs. 2,15,000. You may assume that
production is carried on evenly throughout the year and wages and overhead expenses accrue similarly.
Determination of level of Current Assets:

Determining the optimal level of current assets involves a trade-off between costs that rise with
current assets (carrying costs) and the costs that fall with current assets (shortage costs).

Carrying costs are mainly in the nature of the cost of financing higher level of current assets,
and shortage costs are mainly in the form of disruption in production schedule, loss of sales,
loss of customer goodwill etc.

These two costs will determine the total costs, and the level of current assets at which total cost
is minimum, will be the optimal level of current asset. It is shown as
Generally, the total cost curve is fairly flat around the optimal level hence, it may be
difficult to precisely identify the optimal level.
Sources for Financing Working Capital:

1. Trade credit
2. Accruals
3. Deferred income
4. Commercial papers
5. Public deposits
6. Inter-Corporate deposits
7. Commercial banks
8. Factoring
THANK YOU

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